LONDON: German bonds rose on Monday as concern at the outcome of Spanish regional elections outweighed the market's growing optimism that lenders will finally come to an agreement on Greek aid payments.
Separatist parties from Spain's Catalonia region won almost two-thirds of seats in the local parliament, backed by voters frustrated over the country's economic crisis and a tax system seen as unfair to the wealthy region.
While the result underlined the political difficulties facing Spain's government, it fell short of the convincing separatist win needed to mount a push for a referendum on independence for the region.
Because of this, the outcome was subject to different interpretations in financial markets but safe-haven Bund futures made marginal gains, rising a modest 17 ticks to stand at 142.29 while European equity markets fell.
Traders said the election result had also given some opportunistic investors a reason to buy back in at cheaper levels after a sustained sell-off last week.
Although there was limited reaction in Spanish debt, where 10-year yields edged 3 basis points higher to 5.67 percent, the election impact could be felt more over the longer term, analysts said.
"The separatist movement may ultimately impact on the market due to fiscal concerns," Rabobank strategists said in a note.
"Namely the worry that the central government's appetite for bringing the regions to heel in terms of budgetary alignment may be limited due to the risk of stoking secessionist ambitions."
BUND OUTLOOK MIXED
Safe-haven German debt recovered some ground lost last week, when Bunds fell almost a point, on the growing likelihood that lenders would agree a way to pay out much-needed bailout funds to Greece.
Belgium's borrowing costs meanwhile fell to new record lows at its final debt auction of the year, as it raised more money to fund 2013 requirements.
It paid 2.252 percent to sell 10-year bonds, yields on which had neared 6 percent late last year, when Belgium was viewed as a possible candidate for a bailout.
Euro zone finance ministers and the International Monetary Fund meet on Monday to discuss how to make Greece's towering debt levels more manageable, a necessary condition for the release of the country's latest aid payments.
"Agreement on the next aid tranche will not trigger any strong movement because it is well expected by the market - I don't think this will bear on the Bund any more than it already has," said BNP Paribas strategist Patrick Jacq.
But the strength of expectations left the market primed for a safe-haven rally if leaders disappointed and delayed a decision further.
"Everyone's fairly relaxed they're going to do some sort of a deal and so if they don't the price action could be quite vicious," a trader said.
Longer-term, the clamour for the safety of German Bunds, which has pushed yield to historically low levels, could subside if attempts to set Greece's debt on a sustainable path are deemed credible by the market.
Options under discussion include a lowering of the interest rate on loans to Greece, deferring interest payments and buying back privately-held Greek bonds.
"Anything that could improve the overall situation in Greece could remove part of the risk-off (move) and therefore could slightly weigh on safe-havens, for sure," Jacq said.
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